What will the George Osborne ‘devolution revolution’ mean for local councils?

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Christopher Bovis does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Chancellor of the Exchequer George Osborne has announced the government’s intention to revolutionise the way local authorities pursue economic growth. At the Conservative Party Conference, Osborne unveiled his plan to end uniform business rates across the UK – a move that signals a massive political change in the way local government is financed.

The plan is to devolve powers from Whitehall, giving local authorities more freedom and flexibility in the way they collect and spend money in their areas. The changes present a mixed bag of opportunities and risks for local government. But first, here’s a run down of what Osborne’s “devolution revolution” entails, and how builds on what’s gone before.

Traditionally, local government has been financed by a mixture of centrally administered funding and locally administered charges and taxes. The latter includes business rates, which are taxes paid by the owners and occupiers of commercial and industrial properties to local authorities, based on the value of these properties.

The rate is currently set by central government, and collected from businesses by local authorities on its behalf, raising about £11.5bn per year. Around £9.4bn of the funding is then redistributed to local authorities, according to a formula based on each locality’s population, in a way that accommodates regional performance and growth patterns.

What’s the deal?

Osborne wants to change this arrangement, by giving local authorities the power to lower business rates, and allowing them to keep the funds they collect. By the end of life of the current parliament, local governments will be able to retain all revenue from business rates – an estimated worth of £26bn up to 2020.

Local authorities will also have the power to reduce business rates. The idea is that this will help local governments attract businesses to their area, to help boost enterprise and economic activity. Areas which opt for city-wide elected mayors will be given further powers to increase rates by as much as 2p in the pound, for spending on local infrastructure projects, provided that local businesses agree.

The new reforms will also allow local authorities more autonomous financial planning for services, while phasing out the core grant from Whitehall will ensure that the government isn’t spending more on local authorities than taxes bring in. Maintaining fiscal neutrality in this way is crucial for a balanced budget, as it ensures that local government does not receive direct transfers from Whitehall, on top of locally collected revenue.

Baby steps

The previous government took the first steps down the path to further devolution, by introducing a business rates retention scheme in 2013. This allowed local authorities to keep 50% of locally collected business rates.

The aims of this scheme were to create a direct link between business rates and local authority income, give local authorities an incentive to promote economic growth in their areas and reduce their dependency on grants from the central government.

Based on its preparatory work for the act, the government believed that the retention scheme should give local authorities a strong incentive to invest in growth, and that it could contribute in excess of £10bn to the economy by 2020. The scheme is considered successful by the government, providing assurances that this type of fiscal devolution is the way forward.

Risks and rewards

The biggest opportunity to arise from the abolition of the uniform business rate will be the potential for competition among local authorities. The incentive is that by attracting businesses to their area, local authorities will increase the number of business rate-payers, and therefore their overall revenue. They can do this by lowering business rates, which will, in turn, make business more profitable and attract investors to the area.

The biggest threat posed by the changes will be the potential for regional differences between local authorities. Authorities in areas which are not asset-rich, or which struggle to keep businesses in the territory or attract new ones, will see a dramatic reduction in their revenue. This, in turn, will impact on local services, which could lead to a vicious cycle where the relatively poor quality of local services will deter businesses from establishing in the area in the future.

Indeed, this raises questions about what the changes will mean for the chancellor’s Northern Powerhouse initiative. One worry is that scrapping universal business rates might perpetuate the north-south divide in the UK, since local authorities in the south have a bigger, better pool of assets than those in the north.

To prevent this from happening, the central government will need to provide a safety net. This will be best achieved by the continuation of the current “tariff and top up” system, which will ensure adequate funding to local government in cases where revenue from business rates is not sustainable.

In fact, scrapping the uniform business rates could be seen as a pillar of the Northern Powerhouse. After all, it is a means of fiscal devolution. If local authorities want a devolved agenda, with the revenue from business rates at their disposal for future investment in public services and infrastructure, then they have the funding mechanism in hand.

Of course, the more successful a local authority becomes in retaining business rates and enlarging the amount of businesses which are located in its area, the less direct transfers it will receive from the central government. But fiscal devolution could also trigger further cuts to local government. So it could become a disincentive for local authorities to improve their performance, since it could mean they will receive less direct funding from Whitehall.

The abolition of the uniform business rates, and the ability of local authorities to retain this revenue, will cultivate a competitive mentality which is based on inward direct investment principles. Local authorities will be acting like federal states, striving and competing with each other for businesses to come and invest in their area, to enhance local and regional growth and employment.